Economic conditions, lending competition, and evaluation effect of credit line announcements on borrowers

This paper examines the determinants of the signaling effect of acquiring lines of credit (LCs) on borrower stock returns by testing the economic conditions and lending competition hypotheses. The economic conditions hypothesis is tested by examining the loan cyclicality and handpicking effects. The former predicts a negative relationship between economic conditions and borrower returns because of banks' loose (strict) screening practices in a booming (recessionary) economy, whereas the latter expects a positive relation around the time of the LC announcements. The lending competition hypothesis proposes that the more competitive the lending market is, the looser the banks' screening practices will be. Thus, a negative competition-borrower relation will result. Using LC data from 2001 to 2010 concerning 501 stock-listed firms in Taiwan, we find that evidence supports the lending competition hypothesis and the handpicking effect of the economic conditions hypothesis.

► Banks strictly (loosely) screen borrowers in a booming (recessionary) economy. ► The economic conditions-borrower return relation is positive for credit-line events. ► The more competitive the lending market, the looser the screening by banks. ► The lending competition-borrower return relation is negative for credit-line events.